Japanese real estate is beginning to gain the attention and capital of domestic investors and foreign asset owners could follow, as they seek out alternative investments amid signs that low interest rates will continue in the US, say fund managers.

Institutional investors have increasingly turned to alternative investments to offer some yield after the US Federal Reserve cut its benchmark by 25 basis points to 1.75% on October 30. In Japan, their interest has particularly focused on their demand has especially been for low-risk real assets such as core real estate.

Fund houses are seeking to benefit. On November 20, real estate fund manager LaSalle Investment Management (LaSalle IM) officially launched an open-ended core real estate fund targeting Japan. The LaSalle Japan Property Fund launched with ¥61 billion ($560 million) of initial equity commitments, entirely from Japanese investors.

“Our endeavour has benefitted by the current low interest rate environment, not only in Japan but globally where it has reversed,” Keith Fujii, Japan chief executive officer and chief investment officer at LaSalle IM, told AsianInvestor.

About 50% of the new fund’s equity commitments are from financial institutions, another 25% is from pension funds and the last 25% was from mainly corporations and high net worth individuals, he noted.  

“We managed to launch the fund entirely with domestic capital. Japanese investors prefer something they recognise, and it shares a lot of similarities with private REITs (real estate investment trusts) which are well-known real estate products in the market," Fujii added. 

The appeal of core property funds makes sense, particularly for Japanese investors. Typically investors in core property funds can expect to achieve an annualised return of between 7% and 10% annualised return, while the funds use less than 40% debt to capitalise transactions. Most of the expected return is expected to be generated through cash flow from the property rather than appreciation.

Fund managers told AsianInvestor that the target return for Asia core-focused funds has declined somewhat of late, possibly in part due to the rising volume of funds chasing assets. But with 10-year Japanese Government Bonds yielding -0.10% on Monday (November 25), even a slightly lower yield still looks pretty appealing.

LOWER ACTIVITY

The increasing investor interest could begin to reverse a recent decline in transactions in Japan’s property market.

The country’s commercial real estate transaction volumes stood at $31.3 billion for the 12 months from October 2018 through September 2019, 12.25% lower than the previous 12 months, according to Real Capital Analytics (RCA), a data provider tracking commercial real estate deals.

While the level of buying and selling activity has dipped a little, local real estate investors say Japan's core property prices have stayed consistently high in this late-cycle market, and institutional investor and local buyer demand remains strong for good assets in Tokyo and other major commercial hubs. 

“On the whole, Japanese investors had scaled back their allocations into real estate slightly over the past year, both domestically and overseas. However, with over $20 billion of investment globally so far in 2019, they continue to remain an important source of capital,” David Green-Morgan, managing director in Asia Pacific for RCA, told AsianInvestor.

A rebounding of investment would make sense, given signs of a broader increase in institutional investor demand for alternative investments in Japan. A JP Morgan Asset Management survey of corporate pension funds in the second quarter of 2019 said the 112 respondents allocated a record 21.3% of their portfolios on average to alternative investments. That compared to 12.8% in the 2015 version of the survey, and just 5.4% in the 2009 one. LINK

Furthermore, specific real estate asset types, such as multifamily residential, are gaining more traction with asset owners in Japan.

LOCALS DOMINATE

LaSalle IM’s Fujii thinks that overseas investors could follow local asset owners into Japanese commercial real estate, as they also search far and wide for some asset diversification and investment yield.

“We believe especially European institutional investors would find the diversification to Asia’s most institutionalised market appealing, given the low interest rate environment there as well,” he noted, referring to the zero-interest rate by the European Central Bank.

LaSalle IM plans to raise capital for the Japan core fund from overseas investors over the next 12 months. The fund manager's initial Japan Property Fund portfolio includes six assets bought for ¥105 billion ($965 million), including 40% leverage. The fund aims to grow to ¥200 billion in three years and ¥300 billion in five years.

However, property funds acting on behalf of local and foreign investors may find it challenging to find good assets in Japan’s highly competitive market. Sources told AsianInvestor the country’s commercial real estate is tightly held by local property firms which transfers existing or newly developed assets into designated private or public real estate investment trusts (REITs), often affiliated with the same corporation.

This norm means that Japanese investors have accounted for over 80% of all transaction volumes in the last four out of five years, including the first nine months of 2019, RCA data shows. 

“Grade A office asset in prime locations are almost never traded outside the circles of domestic real estate firms,” a Tokyo-based real estate advisor told AsianInvestor. “And if they are, investors will often be bidding each other up in an on-market offering, as intended by the seller.”

A new potential influx of foreign institutional investor money would likely cause prices to rise further, as appealing buildings are auctioned off. And that could further crimp the sort of investment yield the funds attempt to attain.

That possibility will likely factor into foreign investor equations as they weigh the merits of Japan's property market. They need to decide whether, at a time of low interest rates, this large but closed and expensive market is worth the hassle.